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What Is Commodity Trading?

    IndianMoney.com Research Team | Saturday, October 12,2013, 06:30 PM
 

Since ancient times trading in commodities has been part and parcel of global history. One has heard of the barter system where goods and commodities were traded in exchange for other commodities based on necessity. If one commodity was in plenty in a particular area it was traded for another commodity which was scarce in that region. This led to a balance in all the necessary commodities in that region. The barter system led to the birth of commodity trading in India as in the World.

What is a commodity?

Commodity is basically a product which is interchangeable in commerce and can be traded on a commodity exchange. There is very little differentiation between a product from one producer and another. Gold is a commodity which is universally accepted and has similar features in all corners of the globe.24 karat gold is 24 carat gold in India as in all other places .Commodities may be classified into agri-commodities such as spices, soyabean, corn, cocoa and so on. Bullion and other metals may also be traded. Crude oil, natural gas, furnace oil as well as vegetable oils are also traded on commodity exchanges. Trade in commodities offer vast opportunity for traders, speculators and arbitrageurs to make vast profits. However traders need to be aware of the fundamental factors affecting commodity markets. Please click here to learn more about these fundamental factors.

What is a commodity exchange?

Commodity exchanges in India are basically electronic trading and settlement systems with a nationwide presence. A number of brokers are associated with these commodity exchanges who offer online trading in commodities. Electronic trading enables even retail investors to participate in the markets by purchasing small quantities of precious metals and other commodities and holding them in electronic form. The forward market commission (FMC) functions as a regulatory authority in the commodity market. The National Commodity and Derivative Exchange (NCDEX), Multi-Commodity Exchange (MCX) and National Multi Commodity Exchange (NMCE) are the commodity exchanges present in India.

How to open a commodity trading account in India?

In order to open a commodity account one needs to submit an address and an identification proof such as a copy of the voter’s card or the passport, a bank account statement, copy of the PAN card which form a part of the know your client (KYC) norms. This is similar to the opening of a demat account in the equity market. A trading account will have to be opened with National Spot Exchange Limited (NSEL) and a demat account with a depository such as National securities depository limited...A minimum amount of INR 5000 is sufficient to trade in most commodities. The brokerage charges are in the range of 0.1-0.3% of the contract value. Transaction charges are in the range of INR 5-10 per Lakh per contract. The brokerage varies based on the type of commodity. The brokerage may be as high as 1% of the contract value in case of delivery based transactions. The brokerage cannot exceed the maximum limits specified which is 2.5% of the contract value. Commodity transaction tax would be levied at INR 10 per Lakh. of commodity transacted. One has to register with a major commodity exchange to begin trading.

What is a commodity futures contract?

Commodity futures contract is an obligation to buy or sell a fixed quantity of a particular commodity at a certain time in the future at an agreed price. These contracts are standardized on an exchange based on quantity and size (1000 barrels of crude oil) or 1 Kg of gold at a fixed time period say 3 months forward at a fixed price .The type of commodity and the location of the delivery is fixed. This standardization enables trading on a commodity exchange. The commodities traded are delivered at the agreed price irrespective of changes in the market price of the commodity.

How is commodity market trading carried out in India?

  • Let us consider that one is interested in trading in gold in the commodity market. The minimum contract size is 100 grams commonly called lot size .It has to be bought at the price specified in the contract. The contract period is one month or maybe three months forward.
  • Let us consider that one has bought 100 grams of gold at a spot price of INR 3 Lakhs on the traded exchange. The future price one month hence is INR 3.2 Lakhs The contract period is one month..The current margin amount payable is 10% of the contract size or INR 30000.One can purchase a contract of INR 3 Lakhs or 100 grams of gold merely by paying a relatively small amount of INR 30000.The price of gold increased the next day by INR 1000 per 100 grams .The value of gold is now INR 3,01,000 per 100 grams. The trader earns INR 1000 as a profit and is paid this amount. The following day the price of gold falls by INR 500 per 100 grams. The value of gold is now INR 3,00,500. This amount of INR 500 has to be paid by the trader.
  • If one sells the gold contract before the expiry of the contract in this case one month, then one need not actually purchase the gold or take physical delivery of the gold. If one has purchased the gold at INR 3 Lakhs per 100 grams and expects it to rise to INR 3.2 Lakhs per 100 grams in the span of a month and it does so in 10 days then the gold contract can be sold at any time in the span of the contracted one month .In this way a profit can be made.
  • The exchange has both cash and delivery system. The choice is left to the trader .If the contract is to be settled in cash then it is specified and no actual delivery of goods takes place. This contract is settled in cash. If delivery is to be made then the warehouse receipts are required. The option to settle in cash or through delivery can be changed any number of times until the expiry of the contract.
  • In order to convert goods into physical form the trader has to transfer the commodity to the beneficial owner as designated by the exchange. This can be done by submitting a DIS (Delivery Instruction Slip) to the depository participant along with a surrender request form. The signature on the surrender request form is verified by the depository participant The surrender request form is then submitted to the exchange .The exchange will give the date and time of the delivery. The buyer is charged the lifting and transportation charges.
  • Unlike exchange traded funds goods which are traded on the commodity exchange have a better price correlation with the actual physical commodity. This is because each unit of the traded commodity is backed by the actual physical commodity which is stored in the exchange appointed warehouse.

I would like to end this article disbanding the myth that commodity trading fuels inflation in the country. In India spiraling prices of food grains and other commodities fuels inflation .It is widely believed that price manipulations in the commodity markets is the prime cause of this. Commodity trading actually helps in fair price discovery and the prevention of cartelization. A steel trader in India can see the International price of steel at London in real time on his terminal. This gives the trader an idea of the actual price of steel and enables fair pricing. Exchanges also provide price signals of commodity prices to farmers and policy makers through future trading in far month contracts.

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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